capco capital mkt.v2

8/8/2019 Capco Capital Mkt.v2

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Capital Markets

Overview

Volney Stefflre

February 2001


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204 -09 September 2000 Capital Markets Foundation

Capital

Markets

Ive heard these words what do they mean ?

Capital

Internal product

processing

External processflow

Banks

Individuals

Market Control

Intermediaries

& Institutions

Risk

BondsInvestment

BanksShares

Equity

Futures

Options

FX

Custodians

CSDs

Unit Trusts

Banks

SICAVs

FRNs SWAPS

Brokers

Traders

Margin

Funds

Settlement

Stock

Exchange

SWIFT

Cross-

borderSTP

AssetManagement

Back Office

Front

OfficeECNs

Order

Management

IPOs

Redemption

Par

Clearing

HouseTreasury

Nostros

Depots

The Capital Markets


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What is Capital ?

To many people it is the value of their assets -

property, bank deposits, cars, jewelry etc - net of

their liabilities.

Economists define capital as assets other than labor

and land, which are used to facilitate production.

Capital Goods include plant and machinery.

In the financial markets capital refers to cash and

often the related financing instruments, in particular

fixed income securities and equity.


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Who Supplies Capital ? (Purchases financial products)

Firms

Individuals

Funds:

Investment/ Mutual

Insurance

Pension

Hedge etc

Banks, Governments and probably everyone else


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Who Demands Capital ? (Sells financial products)

Governments

Local Governments - Councils, Municipal Orgs

Government Agencies - Public Sector Orgs - FNMA

Firms

Banks

Finance Companies

Savings Institutions

Individuals


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Buyers & Sellers - distinctions

Institutional

Financial companies which invest their client money in

portfolio of securities on a collective or pooled basis/ issue

financial instruments

Retail Man on the street

- Indirect investors/ issuers


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So what are Capital Markets ?

Capital markets are markets in which financial

securities like stocks and bonds are bought and sold.

Markets in which medium and long term finance is

raised, facilitating the flow of funds.


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Investors

The importance of capital markets

N

eed financingSurplus funds

Capital Markets

generated cash financial assets

cash to

invest

dividends/interest

require

investment

Reinvestment

Firms


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Consumer(You) - requests the purchase a specified amountof one stock

Broker/ dealer - buys a specified amount of 1 type of stock

Example 1 - simple share purchase

Investment Returns


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Consumer(You) - requests the purchase a specifiedamount of one fund

Fund Manager - orders the purchase of a specified amount ofa number of stocks and bonds which make up the fund etc

Example 2 - purchase of a fund

Broker/ dealer- buys a specified amount of a number of stocksand bonds etc

Investment Returns

Investment Returns


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Consumer(You) - contributes to a pension fund

Pension Fund Manager - orders the purchase ofa specified amount of investment/ mutual funds etc

Example 3 - purchase of a pension

Fund Manager - orders the purchase of a specified amount ofa number of stocks and bonds etc

Investment Returns

Investment Returns

Broker/ dealer- buys a specified amount of a number of stocksand bonds etc

Investment Returns


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The Big picture


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The life of a trade

local

custodian

The national securities governing body

Central Bank

payment system

local

custodian

registry/depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

intl buying

broker

intl selling

broker

local broker/

participants

local broker/

participants

selling

fund manager

buying

fund manager

2 2

6 6

7 71 1

16 168 8

9 915 15

13

1312

12

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

intl buying

broker

intl selling

broker

local broker/

participants

local broker/

participants

selling

fund manager

buying

fund manager

2 2

6 6

7 71 1

16 168 8

9 915 15

13

1312

12

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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Trade date - 1

Step 1Investor/fund manager (the client) places an order to buy or sell

securities in a particular market with a broker/ dealer.

NB. The instruction sent by the client will be in a mutually agreed upon

format, most likely by client workstation or by fax.

Step 2

Where necessary the broker/ dealer will often utilize the services of a

local broker present in the market where the security is to be traded.

NB. Local regulations, convenience.


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Trade date

Step 3Stock exchange trades - brokers enter their orders into the trading

system of the stock exchange where they are matched.

OTC trade - communication would occur between brokers through an

organized system, direct via phone, e-mail or some other form of

communication where they can find a counterparty

Step 4

Following matching/ the trade, a trade confirmation is sent to the

appropriate brokers.

Step 5Stock exchange trades - End of each stock exchange trading session,

the stock exchange sends a summary list of all trades to the Clearing

House.

OTC trade - both buying and selling local brokers send through their

trade details to the clearing house for settlement.


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Step 6Confirmations are then passed on to the Brokers where necessary.

Step 7

Brokers inform their clients (fund managers etc) of their obligations

i.e. funding, shares required and relevant account details.

Step 8 & 9

End of trading cycle - Client sends a settlement instruction to their

global custodian authorizing the transaction (forwarded to local

custodian where necessary). Sent by agreed communication method

i.e.. Workstation, SWIFT, fax, etc. and containing all information aboutthe pending trade:- name of the security, ISIN code, net settlement

amount, counterpart, trade date, settlement date, etc.

Physical intervention is dependent on STP capabilities.

Trade date cont


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Trade date + 1 to settlement day 1

Step 10On the morning of T+1, the clearing house will send out a pending

settlement list to all participants (including custodians) detailing all

trades. Report sent each day.

Step 11

On receipt of the list, the local custodian will match the trade

instructions and assuming they match, will send through an affirming

order to the CSD assuring them that they will do their part to settle

the trade either on the cash or securities side.

Step 12The local custodian must release the securities and cash (may involve

an ICSD like Euroclear or Cedel) which have been bought by contacting

the registry and unblocking them. In a physical market, the local

custodian would arrange for the securities to be transferred to a

holding account at the central depository for the benefit of the buyer.


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Settlement day

Step 13The CSD is responsible for arranging all trades entered into its system

for settlement. Check necessary shares are in registry/ depository,

cash in the a/c and block them. Then arrange their transfer.

Safe settlement will see a simultaneous exchange.

Step 14

Upon settlement in the CSD system, notifications confirming settlement

are sent to all local market participants including local custodians.

Step 15

Upon receipt of the settlement confirmation, the local custodianimmediately forwards the confirmation on to the global custodian.

Step 16

The global custodian in turn forwards the settlement confirmation on to

the fund manager.


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Investment Funds/

Investors

Overview


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

Broker

dealer

Broker

dealerLocal broker

local broker/

participants

Selling

fund manager

Purchasing

fund manager

2 2

6 6

7 71 1

16 168 8

9 915 15

13

13

1212

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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Investment funds - Description

Investment Funds are pools of assets made up fromnumerous individual investors where the assets are

collectively invested in a variety of instruments

around the globe

The fund managers interact with Broker/Dealers toinitiate trades, and with Custodians to manage the

settlement of the executed trades


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Types of investment funds

Pension funds

Insurance funds

Hedge funds - (1) a mutual fund that uses hedging practices by purchasing stocksagainst collateral, selling short, or trading in options in an effort to maximize its profits at

risk. (2) any limited partnership of investors that invests in speculative stocks.

Unit trusts - A unit trust is an open ended collective investment. It is open endedbecause the number of 'units' in each trust will vary according to supply and demand. It is

collective because it pools together the money from many different investors for a

professional investment manager to look after. They invest in equity, bonds, property etc.

Most suppliers of unit trusts charge a one-off fee for their management skills.

Mutual funds - often described as the American version of Unit Trusts.

Collections of high net worth individuals

(investors)/private trusts


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Investment funds - Examples

UBS

Fidelity Investments

Deutsche Bank

Credit Suisse Group AXA Group

Barclays Global Investors

Merrill Lynch


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Fund managers interaction in the life of a trade

fund

manager

broker

global

custodian


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Broker/Dealer

Overview


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

Intl broker

dealer

Intl selling

brokerLocal broker Local broker

Selling fund

manager/investor

Buying fund

manager/investor

2 2

6 6

7 71 1

16 168 8

9 915 15

13

13

1212

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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What does a broker/dealer do?


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Broker/Dealers - Description

Broker/Dealers arrange (broke) deals by either:

matching buy and sell orders placed by clients (acting as

an agent)

or by satisfying a client order, if there are no equal and

opposite orders from another client, by taking a positiononto its own trading book (establishing a proprietary

position).The Broker / Dealer will usually endeavor to

offset any such proprietary position against other client

orders at the earliest opportunity.


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Broker/Dealer - Examples

Merrill Lynch & Co

Morgan Stanley Dean Witter

Lehman Brothers

Credit Suisse First Boston

Goldman Sachs

Salomon Smith Barney

Donaldson, Lufkin & Jenrette Inc

Deutsche Bank


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Brokers interaction in the life of a trade

Fundmanager/investor

BrokerCounterpart

broker

Exchange


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Exchanges

Overview


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

Stock

Exchange

Broker

dealer

Broker

dealerLocal broker

local broker/

participants

Selling

fund manager

Purchasing

fund manager

2 2

6 6

7 71 1

16 168 8

9 915 15

13

13

12

12

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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What does an exchange do?


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Exchanges - Description

The primary role of an exchange is to provide acentralized market place where buyers and sellers

can meet to negotiate asset prices and to execute

trades. Exchanges aim to maximize price

transparency and liquidity at the lowest cost by

providing a centralized trading platform into which

all buy and sell orders are submitted.


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Exchanges - Characteristics

There are two main types of exchanges:

traditional open outcry (floor-based) markets, which

operate in a specific building with a physical trading floor

e.g. NYSE, LIFFE, AMEX,

electronic screen-based stock Exchanges e.g. LSE, Eurex.

Markets may be price/quote-driven or order-driven.

In a quote-driven market, market makers will quote both

bid and offer prices, but the transaction remains an

individually negotiated contract.

In an order-driven market, trading revolves around an

order book where market participants post buy and sell

orders (quantities and prices) at which they are prepared

to trade.


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Exchanges - Examples

American Stock Exchange (AMEX)

Tradepoint

London Stock Exchange


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Clearance &

Settlement

Methods & processes for

transfer of ownership and

funds


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

Intl broker

dealer

Intl selling


Selling fund

manager/investor

Buying fund

manager/investor

2 2

6 6

7 71 1

16 168 8

9 915 15

13

13

12

12

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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Clearing & settlement in the bigger picture

Clearance &

settlement

Custodians

Stock

exchange

Brokers/

Participants

External payment

system

Depository/Registry

Clearing house


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Settlement is the final, irrevocable transfer of cash from

the purchaser to the seller in exchange for the delivery

of securities to the purchaser

What do we mean by Clearing & Settlement ?

Clearing is defining accountability for settlement

instructions submitted either Trade-by-trade or

netting. The Clearing House is often the Central

Counterparty


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Clearing Houses - Roles

A Clearing House is responsible for: Mitigating systemic risk in the financial market place

Managing membership

Keeping positions (including novation and netting)

Managing risk

Preparation of settlement

Managing default


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Delivery versus payment

Delivery versus payment (DVP) is the simultaneousand irrevocable transfer of ownership of an asset in

exchange for the equivalent assured countervalue in

same day funds


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Settlement conventions - Physical Vs book entry

Physical delivery Share certificates and duly signed transfer documents

lodged with clearing house

Book entry

Dematerialized- Computerized record only no physical certificate

- Transfer is by Debit sellers account and Credit buyers

Immobilized

- As above but physical certificates exist in centralized

location


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Settlement conventions - Rolling Vs Fixed

Rolling settlement T+ defined market standard - each day the date rolls on

Majority of markets

e.g. UK

Fixed settlement

Fixed day each week

Trading for week settles on one day

High fail cost e.g. South Africa


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The Custodian

Roles &

Responsibilities


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

Intl buying

broker

Intl selling


Selling fund

manager/investor

Buying fund

manager/investor

2 2

6 6

7 71 1

16 168 8

9 915 15

13

13

12

12

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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What does a custodian do ?


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Custodian - Description

Custodians manage the safekeeping of assets onbehalf of their clients.

Custodians handle all administrative issues that arise

with regard to assets in their safekeeping;

corporate actions announcements,

dividend payments,

securities lending etc.

A global custodian offers both core custody services

and value added services; the latter enables the

custodian to differentiate itself from other players in

the market.


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Local Custodian

The vast majority of global custodians select localagents in foreign countries, the local supplier will in

turn handle direct interfaces with the domestic

clearing settlements and depository systems.

Local suppliers are able to handle business moreeffectively as they have connections within the

market place, no language barriers, and are

knowledgeable of local market regulations


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Custodian - Examples

Citibank

State Street Bank & Trust Co.

Paribas

Brown Brothers Harriman & Co HSBC Group (formerly Midland Bank)

Chase Manhattan

Bank ofN

ew York


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Custody within the life of a trade

investor

global

custodian

local

custodian

clearing & settlement

entity

central depository/

registry

payment system


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Central Securities

Depositories & Registries

Overview


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The life of a trade

local

custodian


Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

Intl broker

dealer

Intl selling


Selling fund

manager/investor

Buying fund

manager/investor

2 2

6 6

7 71 1

16 168 8

9 915 15

13

13

12

12

11 11

14 14

14 14

10 10

10 105 5 5

3 3

OTC

3 & 4

4


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Central Securities Depository - Description

Central Securities Depositories (CSDs) are establishedin domestic markets by governments or privately

owned consortium(s) to hold securities in a central

depository.

They provide a mechanism for the transfer anddelivery of securities.

CSDs usually hold and process securities in book

entry (or electronic) form. Varies.

The CSD will inform the registrar if there is a changein legal. In recent years, securities firms have been

trying to reduce the flows of physical securities, the

depository has been central to this advancement


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Registrar - Description

A professional securities market participantperforming maintenance of the Registry of registered

securities holders.

The registrar will have authorization by way of a

contract with the issuer to maintain the register onthe issuers behalf.

The register may be an aggregation of data, in paper

form and/or on electronic media, identifying

registered persons and confirming their rights to

securities registered in their name and recorded inthe personal accounts of registered persons, which

makes it possible to obtain and forward information

to the registered persons.


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CSDs - Examples

France: Sicovam

Germany: Clearstream (previously Deutsche Brse

Clearing)

Hong Kong: HongKong Clearing

Japan: Japan Securities Depository Centre (JASDEC)

Switzerland: SEGA/INTERSETTLE

United Kingdom & Ireland: CREST

United States of America: The Depository TrustCompany (DTC)


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ICSDs

Examples

Clearstream

Euroclear


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Central depository / registry interactions with

market participants

central

depository

brokers

clearing & settlement

entity

custodians

national securities commission

The life of a trade in a back office environment


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Instruction receiptby:

-SWIFT

-Datafile-Workstation

-WWW

-Manual

Instructionvalidation

Data Integrity

-Isin/sedol

-SD vs. market

standard

-Mandatory fieldcompletion

Trade enrichment-SSI

-Tax and

commissions

Trade Verification-Authorization

-Release

Exposure

management-Client/ cpart

exposure

Account balancevalidation

-Check stock and

cash availability

Cancel/correct

-Trade ref

relationship

MIS

Exchange

CSD

MIS

Settlementadvise receipt

-SWIFT

-Datafile-WWW

-Workstation

-clearing system

Matching-Automatic

-Suggested-Criteria matching

variation

Fails

management-Unmatched/

suggested match

prompt

-Pre and post

settlement advice

Tradeconfirmation

receipt

-SWIFT-Datafile

-WWW

-Workstation

Matching-Automatic


variation

Cash

reconciliation-Statement receipt,SWIFT/datafile

Matching-Automatic-Suggested

-Criteria matching

variation

Stock

reconciliation-Statement receipt,

SWIFT/datafile

Matching-Automatic


variation

Trade date

-Stock/cash

positions at client

a/c level

Settlement

date

-Stock/cash

positions at client

a/c level

P&L

-Trade and

settlement date at

client level

G/L posting

-Direct or datafile

generation

MTM

-Price feed

real/intime.

Contractual/

actual

-At client a/c level

Funding

-Cash balance

reporting trade and

value

Monitor

-Market feeds

Advise-Flag and report

positions by client

-Calculate event

-Generate advice

Chase

-Update responses

-Generate chasers

Process

-Process

cash/stock update

Tax

-Calculation

-Reclamation

Formatting andgeneration of

instruction

-SWIFT-Datafile

-WWW

Acknowledgment(ack/nak)

RegulatoryReporting

-Link to regulator

Connectivity to

clearing systems-Euroclear/cedel

ReportingCorporate eventsTrade capture Delivery Settlement Reconciliation Accounting

The life of a trade in a back office environment


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Trade Lifecycle - Technologies

FIX

8

13 10

local

custodian

Central Bank

payment system

local

custodian

registry/

depository

global

custodian

global

custodianclearing &

settlement

stock

exchange

intl buying

broker

intl selling

broker

local broker/

participants

local broker/

participants

foreign selling

fund manager

foreign buying

fund manager

2 2

6 6

7 71 1

16 168

9 915 15

13

12

12

11 11

14 14

14 14

10

10 105 5 5

3 3

OTC

3 & 4

4

Proprietary

Phone / Fax

Swift


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Questions


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